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Valuation of Mortgage Servicing Rights with Foreclosure Delay and Forbearance Allowed

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  • Che-Chun Lin
  • Ting-Heng Chu
  • Larry Prather

Abstract

We develop a bivariate binomial model to price Mortgage Servicing Rights (MSRs). Our model is an improvement over previous MSR pricing models by explicitly incorporating the realistic assumptions that there are additional costs involved in servicing delinquent loans. In addition to the Hilliard et al. mortgage-pricing tree, we extend additional sub-branches to model the borrower's decision of prepayment, cure, and foreclosure after a loan becomes delinquent. We then investigate how the value of the Mortgage Servicing Right varies with interest rate volatility, house price volatility, delinquency options, deficiency judgments, default penalties, forbearance periods, and speed of adjustments factors. Copyright Springer Science + Business Media, Inc. 2006

Suggested Citation

  • Che-Chun Lin & Ting-Heng Chu & Larry Prather, 2006. "Valuation of Mortgage Servicing Rights with Foreclosure Delay and Forbearance Allowed," Review of Quantitative Finance and Accounting, Springer, vol. 26(1), pages 41-54, February.
  • Handle: RePEc:kap:rqfnac:v:26:y:2006:i:1:p:41-54
    DOI: 10.1007/s11156-006-7032-3
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    References listed on IDEAS

    as
    1. Che-Chun Lin & Lan-Chih Ho, 2005. "Valuing Individual Mortgage Servicing Contracts: A Comparison between Adjustable Rate Mortgages and Fixed Rate Mortgages," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 8(01), pages 131-146.
    2. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    3. Ambrose, Brent W & Buttimer, Richard J, Jr, 2000. "Embedded Options in the Mortgage Contract," The Journal of Real Estate Finance and Economics, Springer, vol. 21(2), pages 95-111, September.
    4. McConnell, John J., 1976. "Valuation of a Mortgage Company's Servicing Portfolio," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 11(3), pages 433-453, September.
    5. Jimmy E. Hilliard & James B. Kau & V. Carlos Slawson, 1998. "Valuing Prepayment and Default in a Fixed‐Rate Mortgage: A Bivariate Binomial Options Pricing Technique," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 26(3), pages 431-468, September.
    6. Kau, James B. & Keenan, Donald C. & Muller III, Walter J. & Epperson, James F., 1995. "The Valuation at Origination of Fixed-Rate Mortgages with Default and Prepayment," The Journal of Real Estate Finance and Economics, Springer, vol. 11(1), pages 5-36, July.
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    Cited by:

    1. Chiang, Shu Ling & Yang, Tyler T. & Tsai, Ming Shann, 2016. "Assessing mortgage servicing rights using a reduced-form model: Considering the effects of interest rate risks, prepayment and default risks, and random state variables," Journal of Housing Economics, Elsevier, vol. 32(C), pages 29-46.

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